Absorption Costing



Revised Income Statement, the Contribution Margin Approach

Part 1)

Unit Cost Under Absorption Costing

Direct Materials Cost per Unit

3.5

Direct Labour Cost Per Unit

1.4

Variable Manufacturing Cost Per unit

4.9

Fixed Manufacturing Overhead Per unit (1600000/400000)

4

Total Cost Per Unit

8.9

E-Company

Income Statement

December 31, 20XX

Absorption Costing Income Statement

Sales (345000 units×$29 per unit)

 

$10,005,000

 

 

 

Less cost of goods sold:

 

 

Beginning inventory

$0

 

Add Cost of goods manufactured (400000units×$4.9 per unit)

$3,560,000

 

Goods available for sale

$3,560,000

 

Less ending inventory (55000 units×$4.9 per unit)

$489,500

 

Cost of Goods Sold

$3,070,500

 

Gross Margin

 

$6,934,500

Variable Selling (345000 units x1.20)

414000

 

Fixed Selling

1200000

 

 

 

$1,614,000

Net Operating Income

 

$5,320,500

 

 

 

Unit Cost Under Variable Costing

 

Direct Materials Cost per Unit

3.5

Direct Labour Cost Per Unit

1.4

Variable Manufacturing Cost Per unit

4.9

Total Variable Cost Per Unit

4.9

E-Company

Income Statement

December 31, 20XX

Variable Costing Income Statement

 

 

 

Revenue (345000 units×$29 per unit)

 

 

$10,005,000

Less variable expenses

 

 

 

Variable cost of goods sold:

 

 

 

Beginning inventory

$0

 

 

Add Cost of goods manufactured (400000units×$4.9 per unit)

$1,960,000 Goods available for sale

$1,960,000

 

 

Less ending inventory (55000 units×$4.9 per unit)

$269,500 Variable Cost of Good Sold

 

$1,690,500 Variable selling (345000 units x1.20)

 

$414,000

 

Total Variable Costs

 

2,104,500

 

Contribution Margin

 

 

$7,900,500

Fixed Manufacturing Overhead

$1,600,000

 

 

Fixed Selling

$1,200,000

 

 

Total Fixed Cost

$2,800,000

 

 

Net Income

 

 

$5,100,500

Part 2)

Absorption Costing

Gross profit ratio

Gross Profit Ratio = (Gross profit / Net sales) × 100

(6934500/10005000)*100

69.31034483

Absorption Costing

Operating Income = (Gross Profit - Operating Expenses)/Net sales

(6934500-1614000)/10005000

66.97%

Variable Costing

Contribution Margin Ratio

Contribution Margin Ratio = (Contribution Margin / Sales) × 100

(7900500/10005000)*100

78.96551724

Variable Costing

Operating Income = (Gross Profit - Operating Expenses)/Net sales

(7900500-2800000)/10005000

50.98%

Part 3)

Reconciliation: $5320500- $5100500 = $/55000 units = 220000 units which makes 4 per unit difference in inventory costs. Essentially $220000 [55000 units x $4] in costs were deferred to the next accounting period under Absorption costing.

Part 4)

The method which has been used to produce additional 10,000 units is Absorption costing as this method is beneficial for manufacturing companies and also Generally Accepted Accounting Principles advice manufacturing companies to use this method as in this fixed manufacturing overhead is charged to inventory and written off pro-rata as part of cost of goods sold. In simple term during the year if we sell 85% of the production, we will expense 85% of the fixed manufacturing overhead. If we sell only 30% of what we make, we will expense 30% of the overhead. The remaining amount [15% in the first instance, 70% in the second] will remain in finished goods inventory.

The following is solved with both the method but absorption costing is used.

10,000 additional units

E-Company

Income Statement

December 31, 20XX

Absorption Costing Income Statement

Sales (355000 units×$29 per unit)

 

$10,295,000

 

 

 

Less cost of goods sold:

 

 

Beginning inventory

$0

 

Add Cost of goods manufactured (400000units×$4.9 per unit)

$3,560,000

 

Goods available for sale

$3,560,000

 

Less ending inventory (45000 units×$4.9 per unit)

$400,500

 

Cost of Goods Sold

$3,159,500

 

Gross Margin

 

$7,135,500

Variable Selling (355000 units x1.20)

426000

 

Fixed Selling

1200000

 

 

 

$1,626,000

Net Operating Income

 

$5,509,500

E-Company

Income Statement

December 31, 20XX

Variable Costing Income Statement

For the Quarter Ending March 31, 2011

 

 

 

Revenue (355000 units×$29 per unit)

 

 

$10,295,000

Less variable expenses

 

 

 

Variable cost of goods sold:

 

 

 

Beginning inventory

$0

 

 

Add Cost of goods manufactured (400000units×$4.9 per unit)

$1,960,000 Goods available for sale

$1,960,000

 

 

Less ending inventory (45000 units×$4.9 per unit)

$220,500 Variable Cost of Good Sold

 

$1,739,500 Variable selling (345000 units x1.20)

 

$414,000

 

Total Variable Costs

 

2,153,500

 

Contribution Margin

 

 

$8,141,500

Fixed Manufacturing Overhead

$1,600,000

 

 

Fixed Selling

$1,200,000

 

 

Total Fixed Cost

$2,800,000

 

 

Net Income

 

 

$5,341,500

Absorption costing:

Profit with 345000 unit

$5,320,500

Profit with 355000 unit

$5,509,500 ...